A rate cut is round the corner, it's a matter of how much

Aastha Gudwani, India Chief Economist, Barclays

Aastha Gudwani, India Chief Economist at Barclays

After the February 7 rate cut by the Reserve Bank of India's monetary policy committee, we have seen some pertinent data releases and a slew of liquidity measures by the central bank. As we write this, liquidity has turned into a marginal surplus, and the data backdrop since then suggests a second successive cut is coming on April 9.

First and foremost, February CPI inflation, at 3.6 percent year on year (YoY), came in even lower than our below-consensus estimate. Daily food price data and the transportation fare hike in Maharashtra in March indicate that CPI inflation could likely inch up to 3.7 percent YoY. This implies January-March CPI inflation is set to average at 3.9 percent, a sizable 50 basis points (bps) below the MPC's 4.4 percent estimate.

Accordingly, we are tracking FY25 average CPI inflation at 4.7 percent and see it softening to 4 percent in FY26.

Moving on to growth, real GDP growth for Q3 FY25 improved modestly to 6.2 percent YoY, up from 5.6 percent, suggesting that the trough is behind us.

High-frequency data since then have been mixed, at best. We are tracking Q4 FY25 real GDP growth at 6.7 percent, implying average growth of 6.2 percent for FY25. If realised, this would be 30 bps lower than the RBI's 6.5 percent forecast.

As the MPC is faced with inflation and growth outcomes below its estimated trajectory, it opens policy space to deliver a second successive policy repo rate cut.

In our base case, we expect the MPC to cut repo rate by 25bps and keep the policy stance unchanged at “neutral”.

However, given the meaningful undershoot versus estimated CPI inflation, there is a strong case for the MPC to deliver a non-standard 35bps cut. There is a precedent for a non-standard cut and hike in the earlier cycles too. If deployed, we view a 35bps cut as a compensation for keeping the stance “neutral” (given the continued global uncertainty) while acknowledging the downside risks to inflation and growth.

Neutral or accommodative?

Leaving the stance unchanged while delivering a policy repo rate cut in the February meeting did disappoint the markets and us alike. But we empathise, global uncertainty in indeed higher than usual and that demands some degree of freedom that a “neutral” stance offers.

A “neutral” stance, in our view, suggests that a pause is also on the table, and not every meeting should be seen as an opportunity to cut.

Against this backdrop, we expect the MPC to continue with the “neutral” stance in the upcoming meeting as well.

In our view, the RBI is fully aware that a rate cut amid a liquidity deficit is akin to a “wasted bullet” and is thus rightly setting the stage for (potential) effective transmission by infusing liquidity into the system in the run up to the April 9 policy outcome.

In our view, the RBI is choosing the liquidity path to indicate an “accommodative” stance, even as it stays optically “neutral”.

There is a visible shift in liquidity management operations since the beginning of the year. Year-to-date liquidity infusion has already exceeded Rs 7.5 trillion, leading to system-wide liquidity finally turning to a surplus at the end of March.

The liquidity surplus is likely to go up, as the latest open market operation (OMO) purchase of Rs 800 billion follows through, further supported by the upcoming bumper RBI dividend at the end of May.

It is common knowledge that the RBI is looking to review the liquidity framework. While we do not expect the contours of a refined framework to be unveiled alongside the April policy statement, we believe durable liquidity infusion measures are here to stay.

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